Part 2: Vertical stock Options SpreadProvided By Options University Factors That Affect Stock Options Spread Pricing
The out-of-the-money vertical stock options spread (June 70
75) has the opposite effect of the in-the-money vertical spread
(June 60 65). As volatility increases, the value of the out-of-the-money
vertical spread will increase. This is because the increase
in volatility assumes that the stock price will be more likely
to move and thus the out-of-the-money vertical call stock options
spread will be more likely to finish in-the-money.
Because of the increased potential of this spreads ability to finish in-the-money, the value of the stock options spread will increase. However, if volatility decreases, the value of the stock options spread will decrease. The rule of thumb is that when volatility increases, an out-of-the-money vertical spreads value increases. When volatility decreases, the spreads value decreases. Below, find a chart showing what happens to option deltas when volatility increases or decreases.
When trying to estimate how your stock options spread will change in price with volatility movement, you must understand how the price and delta of both of your options, (the long option and the short option) will act. It bears repeating again that each stock options spread is different and will act differently depending on where the stock is in relation to the spread and what implied volatility does. A good rule of thumb is that when volatility increases, a stock options spread crunch to its median value. For example, the median value of a five dollar stock options spread will be $2.50 while a $10.00 spread will have a $5.00 median value. Crunching to the median value means that a $5.00 spread that has a medium value over $2.50 will lose value and head toward the median price. That happens with an increase in volatility. Meanwhile, that increased implied volatility will make a stock options spread with a value less than $2.50 increase in value, heading up toward median value. When implied volatility decreases, the value of a $5.00 stock options spread will move away from the median price of $2.50. So, when implied volatility decreases, all the spreads valued above $2.50 will increase in value toward maximum value, while stock options spread valued below $2.50 will lose value and head toward $0. Time effects the stock options spread differently depending on where the stock is. As an example, we will look at the QCOM 65 70 call spread. We view the stock options spread over time and across three different stock prices. First, lets look at the spreads reaction to the passing of time with the stock price of $65.50. Below, find a chart showing what the spreads value does as expiration approaches.
With the stock at $65.50, the stock options spread has $.50 of intrinsic value. Holding the stock price frozen at $65.50 until expiration the spread would be worth $.50. As seen by the table above, the stock options spread loses value as time passes and decreases in value toward its $.50 intrinsic value. Next, we will look at the 65 70 spreads reaction to the passage of time with the stock priced at $67.50.
As you can see, with the stock price located directly in between the two strikes, the price of the stock options spread holds at approximately $2.50 throughout the passing of time. As a rule of thumb, time has very little effect on a vertical spread when the stock price lies half-way (equidistant) between the two strikes of the stock options spread. Now, we set the stock price at $69.50 and observe how the spread reacts over time.
The chart shows that as time passes, this stock options spread increases in value. With the stock at $69.50, the spread has an intrinsic value of $4.50. If the stock held at $69.50 until expiration, the stock options spread would be worth $4.50 because that is the amount of intrinsic value the spread has. As time passes, the spreads value will increase to finally reach $4.50 at expiration. In conclusion, times effect on a vertical spread is contingent on where the stock is in relation to the stock options spread. Discover these secret option trading strategies that will have your friends calling YOU 'the options expert' Click here!
copyright 2005 Stock Options Spread
|